Concerns with Off-Budget Financing in India (UPSC Economy)

Off-budget financing refers to expenditure undertaken through market borrowings by public sector undertakings, autonomous bodies or special purpose vehicles, backed by explicit or implicit government guarantees, without being fully reflected in the Union or state Budget. A classic example: when the Centre wants to fund rail capex, it can route money through the Indian Railway Finance Corporation (IRFC) which raises bonds in the market. The Government guarantees repayment, and the liability eventually lands back on the exchequer – but outside the scrutiny of the annual Budget. Similar structures have been used to finance food subsidies through the Food Corporation of India (FCI), fertilisers, irrigation and power.

Scale of the Problem

Former Finance Secretary Subhash Chandra Garg estimated that off-budget expenditure has accounted for at least 1 per cent of India’s GDP. The Comptroller and Auditor General (CAG), in its 2019 report on Union Accounts, flagged extensive use of such mechanisms and called them a breach of FRBM discipline. At state level, the borrowings by SPVs, state-owned power distribution companies and development corporations have often matched or exceeded half of a state’s FRBM ceiling.

How Off-Budget Financing Works

• Government identifies a capital project.
• Instead of appropriating funds through the Budget, it directs a PSU or SPV to raise debt.
• The PSU issues bonds or takes loans from banks and financial institutions.
• The Government provides explicit guarantee or, more often, an implicit commitment through subventions or annuity payments.
• The spending appears on the PSU's books, not the Government's; fiscal deficit looks lower.

Why It Matters

Decrease in financial accountability

Off-budget spending sits outside Parliament's annual appropriation process. Legislators cannot scrutinise its size, purpose or efficiency during the Budget discussion. The net borrowing picture of the government is understated.

Weakened fiscal discipline

If Government struggles to meet the FRBM deficit target while financing priorities, off-budget routes provide an escape valve. This erodes the credibility of stated deficit numbers and the discipline the FRBM Act was meant to impose.

Enhanced financial risk

When PSUs that borrow against sovereign guarantees fail to service their debt, the liability crystallises on the exchequer. The risk is asymmetric: upside accrues to the PSU during good times; downside falls on the public purse in bad times.

Reduced sanctity of fiscal numbers

Government guarantees and commitments should ideally be consolidated into the debt and liabilities statement. When not accounted, headline fiscal deficit, revenue deficit and debt-to-GDP ratios are systematically understated, misleading rating agencies, investors and citizens.

Interest burden

Bonds issued by PSUs typically carry a spread over sovereign yields. The eventual cost to the exchequer is higher than if the Government had borrowed directly.

Classic Case Studies

• FCI food subsidy: For years, FCI funded unpaid food subsidy claims through short-term borrowings from NSSF at above-market rates. Budget 2020-21 finally moved the entire FCI subsidy on-budget, adding around Rs 1.5 lakh crore to the fiscal deficit.
• IRFC bonds: Long-tenor paper raised by IRFC for rail capex, serviced by Indian Railways through lease rentals. On-budget treatment is partial.
• Fertiliser companies: Issued special bonds to bridge subsidy gaps in the 2000s.
• State power discoms: Borrowed under UDAY and subsequent packages with state guarantees, pushing state liabilities up.
• National Highways Authority of India: Extensive market borrowings backed by annuity commitments.

CAG Recommendations

The CAG, in its compliance audit of Union Accounts, has recommended:

• A clear policy framework for off-budget financing with mandatory parliamentary disclosure.
• Rationale and objectives of each off-budget operation to be tabled before Parliament.
• Annual disclosure of the quantum of off-budget financing and the modalities used.
• Integration of off-budget liabilities into the overall debt and liabilities statement in Budget documents.
• Alignment of state-level off-budget borrowings with Article 293 ceilings.

The Post-2022 Crackdown

Union Government

• Budget 2021-22 moved the FCI food subsidy fully on-budget, eliminating the largest source of off-budget borrowing.
• The Fiscal Policy Strategy Statement now publishes extra-budgetary resources figures.
• A dedicated annexure lists Government-serviced bonds, NSSF loans and EBRs.

State Governments

• The Centre in 2022 ruled that off-budget borrowings by state PSUs from 2020-21 onward would be counted against the state's Net Borrowing Ceiling under Article 293.
• States had to disclose cumulative off-budget borrowings and adjust future borrowing limits accordingly.
• Kerala, Telangana, Andhra Pradesh, Tamil Nadu and Punjab were major affected states, each seeing their fiscal space squeezed.

Why States Push Back

States argue that development needs outstrip formal borrowing limits, and that off-budget vehicles fund vital infrastructure. Kerala approached the Supreme Court in 2023-24 challenging the Centre's curtailment of its borrowings as an unconstitutional reading of Article 293. The case, referred to a Constitution Bench, has significant fiscal federalism implications.

Latest developments (2024-26)

• 16th Finance Commission: Its Terms of Reference specifically mention measures to improve fiscal transparency, including treatment of off-budget borrowings by states.
• Budget 2025-26: Reiterates that extra-budgetary resources of Central PSUs are now minimal, with most food and fertiliser subsidies fully on-budget.
• State discipline: Net Borrowing Ceiling rules have forced states to absorb previous off-budget borrowings into formal debt, improving reported figures but compressing headline fiscal space.
• IFRS and accrual accounting: A pilot on accrual-based government accounting, supported by the CAG and IMF, is expected to improve capture of contingent liabilities.
• Disclosure progress: The Medium-Term Fiscal Policy Statement now includes a clearer schedule of contingent liabilities, state guarantees and EBRs.
• PLI linkage: Several PLI outlays flow through central-sector schemes with full budget disclosure, avoiding off-budget routes of the earlier era.
• GST compensation: The Compensation Cess-backed loan to states (Rs 2.69 lakh crore during COVID) was structured through a special window that preserved transparency while providing fiscal support.

Way Forward

• Full consolidation of contingent liabilities into fiscal deficit metrics.
• Stronger independent oversight through a Fiscal Council.
• Better state-level FRBM enforcement through Article 293 aligned with genuine capital expenditure needs.
• Parliamentary standing committee review of all EBR proposals beyond a threshold.

UPSC Relevance

Off-budget financing is a recurring GS III theme on government budgeting, FRBM, fiscal federalism and CAG audits. Mains prompts link it to fiscal transparency and Centre-state relations. Prelims can test CAG reports, Article 293, and specific SPVs like IRFC and FCI. Candidates should track the Supreme Court Kerala case, 16th Finance Commission recommendations, and Budget disclosures to build a data-rich answer.